Non-binding Voting for Shareholder Proposals

The following post comes to us from Doron Levit of the Finance Department at the University of Pennsylvania and Nadya Malenko of the Finance Department at Stanford University.

In the paper, Non-binding Voting for Shareholder Proposals, which is forthcoming in the Journal of Finance, we develop a theory of shareholder voting for non-binding shareholder proposals. The main difference of non-binding voting from the conventional binding voting mechanism is that the vote tally does not, at least directly, determine the outcome. Instead, the management has the discretion to decide whether or not to implement the proposal, even if the majority of shareholders support it.

Our main question is whether non-binding voting for shareholder proposals fulfills its advisory role by conveying shareholder expectations to the company’s management. We show that when the interests of the management and shareholders are not closely aligned, non-binding voting fails to convey shareholder views and therefore does not play its advisory role. This distinguishes voting for non-binding proposals from voting for binding proposals, where some information is always conveyed.

In practice, the effectiveness of shareholder proposals may be affected by external governance mechanisms, such as the threat of a proxy fight by an activist investor. Our analysis demonstrates that the presence of an activist investor enhances the advisory role of non-binding proposals, but only if there is substantial conflict of interest between the activist and shareholders. If the activist’s interests are closely aligned with those of shareholders, non-binding voting still fails to convey shareholder expectations.

Altogether, the presence of activist investors who can discipline the management can improve the effectiveness of non-binding proposals. One implication of this result is that shareholder proposals are likely to become more prominent if the number of shareholder activists increases and their costs of organizing a proxy fight decrease. This prediction is consistent with the recent contemporaneous increase in the number of shareholder proposals and the number of proxy contests, as well as the rise of hedge funds.

The paper also shows that in some cases, non-binding voting can be more effective than binding voting in conveying shareholder expectations. Hence, even if shareholders had a choice, they might prefer shareholder proposals to be non-binding.

The full paper is available for download here.

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